Cash: Master or Slave?

As the economy continues to sputter along I continue to see more organizations tightening their operational belts, sometimes at the expense of future growth. As sales begin to decrease organizations cut the ‘extras’, these include R&D, marketing and many times sales staff. Often these core functions, although conserving immediate cash, acts to cripple the future of the organization; when the economy does begin to run again.

What should organizations do? Warehouse cash until things turn around or spend what cash they have on hand. I believe the answer lies within the culture of the organization and its place on the competitive continuum. Over the past couple of years I have written how organizations sit on an economic continuum predicated by their competitive advantage and their culture. I believe the organization’s place on the economic continuum will strongly influence how they manage their existence during this, and any, economic season.

Of late, for many organizations cash flow has been and will be generated by ‘slash and burn’ models. Basically these organizations cut expenses to the core to keep the lights on, pay down debt or act as a backstop to future financial meltdowns. For many of these organizations, the drop of the gavel has meant cuts to corporate assets, like property, plant and equipment; the very assets that could be leveraged towards a greater competitive advantage both now and into the future.

As organizations have slashed their spending, the free cash flow generated from this behavior, as a recent study shows – has been warehoused. According to a study by the Georgia Tech Financial Analysis Lab using data provided by Cash Flow Analytics, from December 2008 to March 2010 the amount of free cash held by 4,000 U.S. public non-financial services organizations doubled, from $14 million to $28 million. This represented the highest level of free cash flow in the decade. While over the decade capital expenditures as a percentage of revenue fell from 5% to 3%.

For many organizations has become, swap long-term economic health or enhanced competitive advantage for a short term ‘glow’. There is no doubt that holding cash in an uncertain economy makes sense. But warehousing cash without consideration to making the organization stronger and more resilient makes no sense. This behavior mimics the human physiology, in that a rapid drop in the food supply puts the body into survival mode and all fat burning stops. While a more concerted approach leads to consistent weight loss.

According to a study by Charles Mulford, a professor of accounting at Georgia Tech, a few larger public organizations have maintained an upward trend in their capital expenditures along with maintaining a healthy cash flow. Are these organizations operating in a vacuum? Are they not experiencing the daily ups and downs of this sputtering economy? Or do they know something else, some thing other organizations simply haven’t seen. These organizations, I believe, have a clearer understanding of the different types of organizational capital and their position on the economic continuum. From the study, these organizations had different reasons for their commitment to continued capital expenditures. However the most common reason was to maintain their market leadership (domestically or internationally) and keep competition at a considerable distance. The resounding mantra of these organizations was their adherence to a long term strategic plan

A commitment to a long term strategic plan carries more than consistent spending on capital expenditures it requires a complete commitment of the organization to managing a working capital portfolio of funds to meet current, mid-term and long term needs. An organization who hasn’t worked out the nature of their capital, their culture and their vision is destined to crash and burn under the weight of being a slave to cash. While the organization that is committed to their place in the future while having a strong understanding of their working capital composition, and their cash flows will be the master of their free cash.